Paper 3 Mock exam

Question 1

The US dollar is currently trading against the euro at a rate of US $1 = €0.8. What is the rate for € 1 in US $?

Answer 1

US $1 = €0.8, then €1 =
10.8 = US $1.25.
Thus, €1 = US $1.25

Question 2

US $1 = €0.8, then €1 =
10.8 = US $1.25.
Thus, €1 = US $1.25
With the exchange rate above, what would be the cost in euros of a good that was selling for US $75?

Answer 2

If the good is selling for US $75, then it will cost 75 × €0.8 = €60.

Question 3

If the exchange rate changes from US $1 = €0.80 to US $1 = €0.90, explain what would happen to the euro price of a US-manufactured dress shirt that was being exported to Europe from the USA at a cost of US $150?

Answer 3

With the original exchange rate of US $1 = €0.8, the dress shirt would cost €120 (150 × €0.8). With the new exchange rate, the value of the euro has depreciated. It now costs more euros to buy the same amount of dollars, and so the price of the dress shirt increases to €135 (150 × €0.9).

Question 4

January 2020
1.22
December 2020
1.69

1:What was the percentage change in the value of the euro between January and December 2020?

2:find the percentage change in the dollar$:

Answer 4

1:% change in euros (January to December) =
(1.69 - 1.22)/1.22 = 0.471.22 x 100 = 38.52%. Therefore, the euro appreciated by 38.52% relative to the US dollar in 2020.
.

Question 5

Elements of the balance of payments

What do all of the elements added together equal?

Answer 5

Current account + Capital account + Financial account

all = 0

Question 6

What is the Current account?

Answer 6

The current account in the balance of payments is the sum of: (i.) the balance of trade in goods; (ii.) the balance of trade in services; (iii.) income inflows minus outflows; and (iv.) current transfer inflows and outflows.

Question 7

What is the Capital account?

Answer 7

The capital account of the balance of payments of a country is composed of inflows minus outflows of funds for capital transfers and transactions in non-produced, non-financial assets.

Question 8

What is the Financial account?

Answer 8

The financial account of the balance of payments consists of inflows and outflows of funds for (i.) foreign direct investment; (ii.) portfolio investment; (iii.) reserve assets, and (iv.) official borrowing.

Question 9

How do you find the size of tariff?

Answer 9

Pw+t minus Pw

Question 10

How do you find the Quantity of imports for both before and then after a tariff?

Answer 10

Qd1 - Qs1 (before the tariff) and Qd2 - Qs2 (after the tariff)

Change in the quantity of imports is equal to the difference between the quantity of imports before the tariff and the quantity of imports after the tariff.

Question 11

How do you find the Import expenditure?

Answer 11

Price (Pw/ Pw + t) x quantity of imports.

Change import expenditure is equal to the difference between import expenditures before the tariff and import expenditures after the tariff.

Question 12

What is consumer expenditure before the tariff and then after the tariff?

Answer 12

Consumer expenditures before the tariff are equal to Pw x Qd1. After the tariff, consumer expenditures are equal to Pw+t x Qd2

Question 13

How do find the change in consumer expenditure?

Answer 13

Change in consumer expenditure is equal to the difference between consumer expenditures before the tariff and consumer expenditures after the tariff.

Question 14

What is producer revenue before the tariff and then after the tariff?

Answer 14

Producer revenue before the tariff was equal to Pw x Qs1. After the tariff, producer revenue is equal to Pw+t x Qs2.

Question 15

How do find the change in Producer revenue?

Answer 15

Change in producer revenue is equal to the difference between producer revenue before the tariff and producer revenue after the tariff.

Question 16

How do you find the Government revenue when there is a tariff?

Answer 16

Government revenue is equal to area E, or the per unit tariff multiplied by the quantity of imports (after the tariff)

Question 17

How do you find consumer surplus?

Answer 17

Consumer surplus is measured as the area below the demand curve and above the price (Pw/ Pq). Or,
(P intercept of D curve minus P of consumers) x Q purchased2. Change in consumer surplus is equal to the difference between consumer surplus before the tariff and consumer surplus after the tariff.

Question 18

How do you find Producer surplus?

Answer 18

Producer surplus is measured as the area above the supply curve and below the price (Pw/ Pq). Or,
(P producers minus P intercept of S curve) x Q sold2. Change in producer surplus is equal to the difference between producer surplus before the tariff and producer surplus after the tariff.

Question 19

How do you find welfare lost?

Answer 19

Welfare loss is measured as the area of the two shaded triangles, Or
(height of welfare loss triangle) x (lengths of welfare loss triangle)2.
The sum of both triangles completes the calculation for welfare loss.

Question 20

How do you find the size of the quota?

Answer 20

Qd2 - Qs2 (the permissible number of units that can enter the country per time period). The domestic supply curve will shift to the right by this amount.

Question 21

How do you find the quantity of imports before and after the quota?

Answer 21

Qd1 - Qs1 (before the quota) and Qd2 - Qs2 (after the quota). Change in the quantity of imports is equal to the difference between the quantity of imports before the quota and the quantity of imports after the quota.

Question 22

Give 2-3 International Trade Policies

Answer 22

Tariffs
Quotas
Production subsidies
Export subsidies
Administrative barriers

Question 23

Give 3 types of Economic Integration

Answer 23

Formation of trading blocs (free trade areas, customs unions, common markets)
Monetary union
Membership of the World Trade Organization

Question 24

Give types of trading blocs

Answer 24

free trade areas, customs unions, common markets

Question 25

Give the types of expenditure switching policies

Answer 25

Trade protectionist policies (ie, tariffs, quotas or subsidies)

Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit.

Question 26

Give the types of expenditure Reducing policies

Answer 26

Contractionary monetary policy could be used to correct a long-term current account deficit

Contractionary fiscal policy could also be used to correct a long-term current account deficit

Question 27

Explain the difference between a free-trade area and a customs union.

Answer 27

A free trade area is when there are multiple states that agree to open up free trade between each other by eliminating or reducing the use of tariffs or other trade barriers. A free trade area and custom union work similarly however there is one key difference. All members of a customs union have to follow the same trade protectionist policy.

Question 28

What are the advantages of being a part of a common market

Answer 28

Increased competition – The removal of trade barriers within trading blocs results in increased competition among producers in member countries.

Improved efficiency in production – The elimination of trade barriers and free trade lead to improved efficiency in production, as inefficient producers lose their protection.

Lower prices for consumer and greater consumer choice – The elimination of trade barriers (along with increased competition and economies of scale) results in lower prices for consumers.

Access to markets and economies of scale – A country that joins a trading bloc would have access to the markets of the whole bloc.

Question 29

What are the disadvantages of being a part of a common market

Answer 29

One problem that arises in a customs union is that member countries must coordinate their policies toward non-members. This gives rise to the possibility of disagreements, as they may not all agree on what are appropriate levels of tariff and other barriers on non-members.

Loss of sovereignty-As integration becomes greater, countries will lose some degree of economic and political sovereignty.

Undermine trade liberalization (free trade) – The establishment of many trading blocs can create trade conflicts between different blocs that may slow down the process of global trade liberalization (free trade).

Question 30

Explain at least two factors that might lead to an increase in the demand for a currency.

Answer 30

Foreign demand for exports of goods and services – If there is an increase in foreigners’ demand for US goods, the demand for exports increases and the demand for dollars rises.

Inward foreign direct investment (FDI) and portfolio investment – There are two types of investment: foreign direct investment (investment by multinational corporations in productive facilities) and portfolio investments (financial investments, such as purchase of stocks and bonds). Both types of investment have the same impact on exchange rates.

Relative interest rates – Financial capital refers to funds that are used to make financial investments that receive a return based partly on the rate of interest.

Speculation that a currency will appreciate – Currency speculation involves buying and selling currencies to make a profit from changes in exchange rates.

Question 31

What are the consequences of a depreciation of a country’s currency on inflation, unemployment, and the standard of living.

Answer 31

Inflation – If the value of the exchange rate is low, both demand-pull and cost-push inflationary pressures may rise. This is because a lower value currency, by making exports cheaper and imports more expensive, works to increase the quantity of exports and lower the quantity of imports, thus increasing net exports (X-M).

Standard of living – If the value of the exchange rate is low, it causes imported goods to become more expensive in the domestic economy, therefore residents become worse off as all imported goods become more expensive.

Unemployment Decreases as the economy grows.

Question 32

What is a real world example of a countries currency depreciating?

Answer 32

Argentina’s annual inflation rate ended 2023 at 211.4%, the highest since the early 1990s.

Question 33

How can expenditure-switching be used to correct a current account deficit?

Answer 33

Trade protectionist policies could be used to correct a long-term current account deficit. Trade protectionist policies (ie, tariffs, quotas or subsidies) prevent the free entry of imports into a country by raising the price of foreign imports. The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods. However, trade protectionist policies have a number of negative effects, such as higher domestic prices of protected goods and lower domestic consumption. Also, protecting domestic industries reduces competition, which may encourage them to be inefficient. Finally, there also arises a danger that countries against which the protective barriers are imposed may retaliate with their own barriers.

Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit. A depreciation (or devaluation) of currency encourages exports (which become cheaper to foreigners) and discourages imports (which become more expensive to domestic buyers). The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods. However, this policy too may have negative effects on the domestic economy. Higher import prices due to the lower value of the currency often result in higher domestic inflation. If the imported goods include capital goods and other imported inputs, firms experience higher costs of production, which may be passed on to consumers in the form of higher prices. This is a type of cost-push inflation, and by shifting the SRAS curve to the left, may have recessionary effects.

Question 34

What are the negatives of using expenditure switching to correct a current account deficit?

Answer 34

Depreciation (or devaluation) of a currency can have negative effects on the domestic economy. Higher import prices due to the lower value of the currency often result in higher domestic inflation. If the imported goods include capital goods and other imported inputs, firms experience higher costs of production, which may be passed on to consumers in the form of higher prices. This is a type of cost-push inflation, and by shifting the SRAS curve to the left, may have recessionary effects.

Trade protectionist policies have a number of negative effects, such as higher domestic prices of protected goods and lower domestic consumption. Also, protecting domestic industries reduces competition, which may encourage them to be inefficient. Finally, there also arises a danger that countries against which the protective barriers are imposed may retaliate with their own barriers.

Question 35

What makes the use expenditure switching to correct a current account deficit effective?

Answer 35

Trade protectionist policies could be used to correct a long-term current account deficit. Trade protectionist policies (ie, tariffs, quotas or subsidies) prevent the free entry of imports into a country by raising the price of foreign imports. The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods.

Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit. A depreciation (or devaluation) of currency encourages exports (which become cheaper to foreigners) and discourages imports (which become more expensive to domestic buyers). The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods.

Question 36

What is a current account deficit? And how does it affect the economy?

Answer 36

A current account deficit is when the current account adds up to be negative.

Exchange Rates: A deficit can lead to currency depreciation due to decreased demand for domestic currency, impacting exports and imports. This can affect households, potentially leading to inflation and reduced competitiveness for firms reliant on imports.

Interest Rates: Financing the deficit may require higher interest rates to attract foreign capital, potentially reducing aggregate demand, causing economic slowdown, and increasing unemployment.

Foreign Ownership of Domestic Assets: Selling domestic assets to foreigners can finance the deficit but may raise concerns about economic sovereignty, especially if strategic assets are involved.

Debt: Financing through borrowing increases foreign debt, requiring interest payments that divert funds from other sectors like infrastructure, health, or education, potentially hindering economic development.

Lower Credit Rating: Accumulating foreign debt may lower credit ratings, making it harder to secure future loans and potentially leading to higher interest rates, exacerbating debt issues and possibly causing or deepening recessions.

Economic Growth: A deficit can reduce economic growth as consumers shift to importing goods, leading to decreased domestic production, layoffs, reduced aggregate demand, and ultimately, a recession with increased unemployment and decreased GDP growth.

Question 37

What are the different expenditure reducing policies, how do they work?

Answer 37

Contractionary monetary policy could be used to correct a long-term current account deficit. Contractionary monetary policy is where the government intervenes in the economy by raising interest rates. This slows down investment (I) and consumption (C), which reduces aggregate demand. The purpose of this policy is to reduce aggregate demand, resulting in lower levels of real GDP (national income), which means consumer incomes are falling and buying fewer domestic and imported goods. The combination of fewer imports and more exports may work to reduce the current account deficit.

Contractionary fiscal policy could also be used to correct a long-term current account deficit. Contractionary fiscal policy is where the government intervenes in the economy by cutting government expenditure (G) or increasing taxes (C or I). This will lead to less aggregate demand in the economy because households are left with less disposable income and firms with less after-tax profits to invest. Similarly, the purpose of this policy is to reduce aggregate demand, resulting in lower levels of real GDP (national income), which means consumer incomes are falling and buying fewer domestic and imported goods. The combination of fewer imports and more exports may work to reduce the current account deficit.

Question 38

What are the drawbacks of expenditure reducing policies?

Answer 38

too much contractionary policy will push aggregate demand too far and may create a recession.

the higher costs of borrowing as a result of higher rates from contractionary monetary policy may create a recession in the domestic economy. Moreover, there is also a risk that higher interest rates (contractionary monetary policy) leads to currency appreciation, which may discourage exports and encourage imports, partly canceling out the beneficial effects of expenditure reducing policies on imports and exports.