AQA A-Level Economics (7136) · The National & International Economy
Specification points
- Exchange-rate systems and the determination of exchange rates.
- The effects of exchange-rate changes.
- The balance of payments and international competitiveness.
Exchange rates
The exchange rate is the price of one currency in terms of another. Under a floating system it is set by demand and supply of the currency (from trade, investment, interest rates and speculation). Under a fixed system the government/central bank maintains a set rate. A managed float combines both.
- Appreciation/depreciation apply to floating rates; revaluation/devaluation to fixed rates.
Effects of exchange-rate changes
Use SPICED — Strong Pound, Imports Cheaper, Exports Dearer:
- Appreciation → exports dearer, imports cheaper → net exports may fall, easing inflation.
- Depreciation → exports cheaper, imports dearer → net exports may rise, subject to the Marshall-Lerner condition and the J-curve (the current account may worsen before it improves).
Key definitions
| Term | Definition |
|---|---|
| Appreciation | A rise in a floating currency's value. |
| Marshall-Lerner condition | A depreciation improves the current account only if the sum of export and import demand elasticities exceeds 1. |
| Current account | Trade in goods and services plus income and transfers. |
The balance of payments and competitiveness
The current account balance depends on competitiveness (relative unit labour costs, productivity), incomes and the exchange rate. Policies to correct a deficit include depreciation, demand reduction and supply-side improvements to competitiveness.
Worked example
A currency depreciates 10%. Exports become cheaper abroad and imports dearer. If the Marshall-Lerner condition holds, the current-account deficit narrows over time — but in the short run, before quantities adjust (the J-curve), it may worsen, and import prices raise inflation.
Common exam mistakes
- Getting exchange-rate effects backwards.
- Confusing depreciation (floating) with devaluation (fixed).
- Forgetting the Marshall-Lerner/J-curve caveats.
Exam technique
State appreciation or depreciation, apply SPICED, then evaluate the current-account effect with the Marshall-Lerner condition and J-curve.
Quick revision
- Floating: appreciation/depreciation; fixed: revaluation/devaluation.
- Depreciation → cheaper exports, dearer imports (M-L condition, J-curve).
- Current-account balance depends on competitiveness, incomes, exchange rate.