Balance of Payments: three questions to try now
Real questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 1
A government decides to devalue the country’s currency to remove the deficit on its current account of the balance of payments. What is the most likely reason why this would not work?
Answer: D.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 2
What is most likely to be an appropriate government action to reduce both a balance of payments current account surplus and the rate of inflation?
Answer: D.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 3
The demand for a country’s exports is price elastic.
If it is experiencing a deficit on the current account of its balance of payments, which combination of policies is most likely to correct the deficit?
Answer: D.
Two mechanisms have to work together. First, depreciation makes exports cheaper in foreign currency and imports dearer at home. The question states that demand for exports is price elastic, which is the condition that makes this work: a given percentage fall in the foreign-currency price raises export volumes by a larger percentage, so export revenue rises. (Where demand is inelastic, depreciation can widen a deficit, the Marshall–Lerner condition.) Second, raising income tax cuts households' disposable income, which reduces consumption and with it spending on imports. Expenditure switching and expenditure reduction together shrink the deficit.
Why the other options are wrong:
- A appreciates the currency, which makes exports dearer and imports cheaper, the wrong direction entirely, and cuts interest rates, which stimulates import demand.
- B gets the exchange rate right but cuts income tax, boosting disposable income and therefore import spending, which works against the depreciation.
- C leaves the exchange rate unchanged, so no expenditure switching occurs, and cuts income tax, raising import demand. The interest rate rise would dampen demand, but it also tends to attract capital inflows and push the currency up.
What this practice covers
These questions are drawn from past Cambridge papers, mapped across to this topic because the concept is the same. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on balance of payments, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Confusing the balance of trade (goods and services only) with the whole current account.
- Forgetting that the accounts must sum to zero, so a current account deficit is financed by a financial account surplus.
- Treating any deficit as automatically harmful without asking what is causing it and how it is financed.
- Assuming a surplus is automatically desirable.
- Placing FDI in the current account. Investment flows go in the financial account; the income they later generate goes in primary income.
- Asserting depreciation will fix a deficit without invoking Marshall–Lerner or the J-curve.
- Stating Marshall–Lerner without explaining that it is about volumes outweighing prices.
- Ignoring the inflationary cost of depreciation.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Balance of Payments revision notes.