Lesson 4.1.8

4.1.8 Exchange rates Quiz: Pearson Edexcel Economics A, Unit 4

20 questions

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Lesson 4.1.8, Exchange rates: 20 multiple choice questions for the Pearson Edexcel Economics A (9EC0), Unit 4: Theme 4: A global perspective, written with Revision Ninja.

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The 20 questions

  1. Which best describes a fixed exchange rate system?

    • The government or central bank sets the currency's value against another currency and intervenes to maintain it
    • The currency's value is set entirely by market forces of supply and demand, with no government intervention at all
    • The currency is set by the IMF once every year and cannot be changed by the government in that period
    • The currency is backed by a fixed quantity of gold and cannot be bought or sold for other currencies

  2. Which best describes a managed exchange rate system?

    • A system in which the currency is pegged to another currency permanently and never allowed to move at all
    • A system in which the currency is determined by market forces only, with no possibility of intervention ever
    • A system in which the currency floats in the market but the authorities sometimes intervene to influence its value
    • A system in which the currency is set by a fixed formula in law and cannot be changed without parliamentary approval

  3. What is the distinction between revaluation and appreciation of a currency?

    • Revaluation is an official rise in value under a fixed system, while appreciation is a market-driven rise under a floating system
    • Revaluation is a market-driven rise in value under a floating system, while appreciation is an official rise under a fixed system
    • Revaluation is a fall in the value of a currency, while appreciation is a rise in the value of the same currency
    • Revaluation and appreciation are the same thing, so the two terms can be used interchangeably in all contexts

  4. What is the distinction between devaluation and depreciation of a currency?

    • Devaluation is an official cut in a fixed value, while depreciation is a market-driven fall in a floating currency
    • Devaluation and depreciation are both rises in the currency's value, but devaluation is official while depreciation is not
    • Devaluation is a market-driven fall in value, while depreciation is an official cut in the value of a fixed currency
    • Devaluation is a rise in the currency's value in a floating system, while depreciation is a fall in the same currency

  5. Which factor is most likely to cause a currency to appreciate under a floating exchange rate?

    • A net outflow of foreign direct investment, which reduces the demand for the domestic currency in the market
    • A rise in domestic interest rates that attracts inflows of short-term capital from abroad
    • A fall in demand for exports, which reduces the demand for the domestic currency from foreign buyers
    • A rise in domestic inflation relative to inflation in trading partners, which lowers the real value of the currency

  6. Under purchasing power parity, a country with inflation of 6 per cent a year compared with 2 per cent in its partner would be expected to see what change in its exchange rate?

    • A depreciation of about 8 per cent a year, since inflation rates are added together when calculating the change
    • An appreciation of about 4 per cent a year, because higher inflation always increases the value of the currency
    • A depreciation of about 4 per cent a year, to offset the higher domestic inflation over time
    • No change at all, because purchasing power parity holds that inflation has no effect on exchange rates

  7. How might a government intervene to stop its currency falling in value under a managed float?

    • Buy foreign currency reserves with domestic currency, which lowers the demand for its own currency in the market
    • Sell foreign currency reserves and buy its own currency, or raise domestic interest rates to attract capital inflows
    • Cut domestic interest rates to encourage capital outflows, which pushes the currency's value upwards over time
    • Ban all foreign investors from buying domestic assets, which lowers the currency's value on the foreign exchange market

  8. What is competitive devaluation?

    • A rise in a currency's value that is made by a central bank to reduce the competitiveness of its exporters
    • A permanent fixing of exchange rates by all countries at the same level so that no country can gain an advantage
    • A single devaluation by one country that is accepted by all trading partners as a fair and orderly adjustment
    • Repeated devaluations or depreciations by countries trying to gain a trade advantage, often provoking retaliation

  9. Which is a consequence of competitive devaluation for the world economy?

    • Higher real interest rates in every country, which encourages all countries to save more and to invest less
    • A permanent rise in world trade as all countries become more competitive and reduce their import tariffs together
    • Retaliatory devaluations that can create uncertainty and reduce trade and investment for all countries involved
    • Equal exchange rates for every currency, which removes all the gains from trade and specialisation in the world

  10. A depreciation of a currency raises the price of imports. Which is the most likely effect on inflation?

    • It always reduces inflation, because a cheaper currency lowers the price of all goods produced in the domestic economy
    • It reduces inflation immediately by the same proportion as the depreciation, without any time lag in the economy
    • It has no effect on inflation, because import prices are set in foreign currency and never change in domestic terms
    • It can add to domestic inflation through higher import costs, especially where imported goods are a large share of spending

  11. Which is the Marshall-Lerner condition?

    • A depreciation always improves the current account, whatever the price elasticities of demand for exports and imports
    • A depreciation improves the current account if the sum of the price elasticities of demand for exports and imports exceeds 1
    • A depreciation improves the current account only if the price elasticities of supply for exports and imports are both zero
    • A depreciation improves the current account only if the price elasticity of demand for imports exceeds 2 in absolute terms

  12. Export demand has elasticity 0.6 and import demand has elasticity 0.5. Does a depreciation improve the current account, under the Marshall-Lerner condition?

    • Yes, since each elasticity is below 1, so both quantities are unchanged by depreciation
    • Yes, since 0.6 + 0.5 = 1.1, which exceeds 1
    • No, since the sum of the two elasticities is 0.11, which is too small for any improvement to take place
    • No, since 0.6 + 0.5 = 1.1, which must be less than 1 for an improvement

  13. Export demand has elasticity 0.4 and import demand has elasticity 0.3. What does Marshall-Lerner imply about depreciation?

    • The current account improves exactly by the size of the depreciation, since the elasticities cancel out
    • The current account improves immediately, because the sum of the elasticities is 0.7 and that exceeds the threshold of 0.5
    • The current account must improve, since both elasticities are positive numbers below 1 in every case
    • The current account is unlikely to improve, since 0.4 + 0.3 = 0.7 is less than 1

  14. What is the J-curve effect?

    • After a depreciation the current account improves immediately and then steadily worsens as volumes fall away
    • A permanent improvement in the current account caused by a rise in the exchange rate that lasts for many years
    • A fall in the exchange rate that is always followed by an immediate and sustained fall in the current account
    • After a depreciation the current account initially worsens before improving, as volumes adjust with a lag

  15. Which is an effect of a currency depreciation on foreign direct investment?

    • Foreign investors are always prevented from investing, because depreciation automatically imposes capital controls
    • Foreign direct investment is unaffected by any change in the exchange rate, because it is based only on trade
    • Foreign investors always withdraw all their capital immediately, since a fall in the currency removes all profit
    • Foreign investors may find domestic assets cheaper in their currency, which can attract FDI inflows

  16. Which factor is most likely to lead to a depreciation of a floating currency?

    • A fall in domestic interest rates that reduces the attractiveness of the currency to short-term foreign investors
    • A rise in demand for the country's exports from foreign buyers, which raises demand for its currency in the market
    • A rise in domestic interest rates that attracts large inflows of capital from abroad into the domestic economy
    • A rise in domestic productivity that raises the competitiveness of the country's export industries

  17. What is the likely effect of a rise in domestic interest rates on the exchange rate of a floating currency, all else equal?

    • The currency depreciates by the full amount of the interest rate rise, regardless of capital flows or expectations
    • The currency tends to depreciate, because higher interest rates always cause a fall in the demand for the currency
    • The currency tends to appreciate, as higher returns attract capital inflows and raise demand for the currency
    • The currency is unaffected, because interest rates influence only domestic borrowing and never exchange rates

  18. A country's currency falls 15 per cent. Which is the most likely effect on its tourism inflows?

    • Inbound tourism falls by exactly 15 per cent, because tourist numbers always move in line with the exchange rate
    • Inbound tourism falls, because a weaker currency always makes a country less attractive to foreign visitors
    • Inbound tourism tends to rise, since foreign visitors find the country cheaper to visit in their own currency
    • Inbound tourism is unaffected, because tourism is recorded only as secondary income and is not affected by prices

  19. Which change would be called a devaluation under a fixed exchange rate system?

    • The authorities announce a lower official value for the currency against the fixed peg
    • The currency's market value rises because interest rates are raised to attract foreign capital inflows
    • The currency's value is unchanged, but the central bank increases its holdings of foreign reserves
    • The currency's market value falls because investors sell it in the foreign exchange market each day

  20. A currency depreciates while domestic inflation is 8 per cent and foreign inflation is 3 per cent. Under relative purchasing power parity, what is the approximate expected depreciation per year?

    • About 5 per cent a year, since 8 minus 3 gives the inflation differential
    • About 8 per cent a year, since the domestic inflation rate is always equal to the exchange rate change
    • About 3 per cent a year, since the foreign inflation rate alone determines the change in the rate
    • About 11 per cent a year, since 8 plus 3 gives the total inflation rate affecting the currency

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