2019 Nov #3 (Exchange Rate, Growth, Current Account, Linear Demand) Paper 3 HL
(a) (i) If a visitor to Gardia from the US buys a towel that costs 23 gamma, calculate the cost in US$.
$1 = 6.2 gamma
23/6.2 = $3.71
(ii) More foreign tourists are visiting Gardia. Outline the effect on the value of the gamma. Give a reason for your answer.
As more tourists visit Gardia, they will demand more Gamma to exchange for their foreign currency. This higher demand for Gamma’s will cause the Gamma to appreciate (become stronger).
(iii) State 2 factors that could cause Gardia’s current account to be in a deficit, even though its balance of trade in goods is in surplus.
(Understand that the current account consists of more that just goods.)
· Gardia could have a greater deficit on its service account, transport or insurance or tourism.
· Gardia could have a greater deficit on its income account, in profits, interest or dividends on its overseas assets or in salaries paid from overseas (remittances might be included here)
· Gardia could have a greater deficit on its current transfer/transfer payments in overseas aid or income remittances or pensions paid overseas.
(iv) Determine the size of Gardia’s current account surplus/deficit when the sum of the financial and capital accounts is US$2 billion.
A surplus in the capital account is a deficit in the current account.
**A deficit of US$2 billion**
(b) Gardia is aiming to increase its economic growth rate. Explain 2 sources of economic growth for economically less developed countries.
· Human Capital – education or more skill training for citizens
· Technology Development - or use of technology that increase productivity
· Technology Adoption – adopting and implementing innovative technologies from overseas with market potential, ex electric cars
· Institutional Changes – improving the efficiency of the legal system or establishing and protecting property rights.
· Foreign Direct Investment – to process local materials so that there is more value added domestically or to provide appropriate technologies.
· Expansionary Fiscal Policy – that will increase AD through raising G or lowering income taxes
· Export Promotion – that will increase AD or that furthers vertical integration in the export sector.
· Depreciation of exchange rates – that will lead to exports becoming more competitive/ imports less competitive: so AD increases.
(c) Calculate the additional cost of paying back the loan in gamma in 2019, due to the interest and the change in the exchange rate.
2018: 4 x 5.3 = 21.2
2019: 4.2 x 6.2 = 26.04
26.04 – 21.2 = 4.84m gamma
(d) Calculate the equilibrium exchange rate for the US$ in terms of gamma.
(e) Plot and label the new supply curve on Figure 2.
Qs = -.5 + g
Step 1 – Make (Qs zero) and solve for g
0 = -.5 + g
g = .5
US$ (0) = (.5 gamma)
Step 2 – Make (g zero) and solve for Qs
Qs = -.5 + 0
Qs = -.5
US$ (-.5) = (0 gamma)
Step 3 - Choose a number for Qs (greater that .5) and solve (I choose 8)
Qs = -.5 + g
8 = -.5 + g
add .5 to both sides
8.5 = g
US$ (8) = (8.5 gamma)
(f) (i) Using Figure 2, calculate how many US$ are needed to buy one gamma at the new exchange rate.
Look at the graph – equilibrium occurs at US$ (3) for gamma (3.5)
So 1 US$/ 3.5gamma = .285 or 29cents
1gamma = .29$
(ii) State 2 reasons that could have caused an increase in the Supply of US$.
· US increases imports or Gardia increases its exports (same thing)
· Gardia’s interest rates increase or US interest rates decrease
· Gardia’s inflation rate (PL) falls or the US inflation rate increases
· US incomes rise at a faster rate than Gardia’s incomes
· More investment (financial and/or direct) flowing from the US to Gardia
· US gov’t/cental bank using dollars to buy gamma
· Speculative selling of dollars (because of expected depreciation)
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