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King’s College

Secondary 7A (2008-2009)

Source: Supplementary Exercises on Balance of Payments Accounting and Adjustments and Exchange Rates
Date of submission: 05/01/2009 (Mon)

Attempt the following questions on single-lined paper.

Exercise 1
1. Under a fixed exchange rate system, explain how a surplus and a deficit in the balance of payments will
affect the foreign exchange reserves of a country respectively. State your assumptions clearly.
2. Under a flexible exchange rate system, explain how the exchange rate of the US dollar will be affected in
each of the following conditions.
(a) There is a rising deficit in the trade balance of the USA.
(b) A Japanese imports computers from the USA.
(c) Many Americans travel in the U.K.
3. “Under a flexible exchange rate system, there is no balance of payments disequilibrium.” Do you agree?

Exercise 2
1. Distinguish between depreciation and devaluation.
2. Explain why a depreciation of a country’s currency will reduce a country’s trade deficit.
3. Explain why a depreciation of a country’s currency does not necessarily improve the country’s balance of
payments position.
4. Discuss the process in which a balance of payments surplus is eliminated under a fixed exchange rate
5. What will happen to the exchange value of a country’s currency under the following situations?
(a) Prices of the country’s imports increase.
(b) The country implements an expansionary fiscal policy.

Exercise 3
1. (a) Refer to Figure A and answer the questions below.
(i) Is the foreign currency under-valued or over-valued?
(ii) To maintain the fixed exchange rate, should the monetary authority buy or sell foreign
currency? What is the amount of foreign currency bought or sold? What is the amount of
domestic currency sold or bought?
(iii) If the monetary authority does not intervene, what will be the black market price of foreign
(b) Refer to Figure B and answer the three questions above.

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Figure A Figure B

2. “The balance of payments account is always in balance but not always in equilibrium.” Discuss.
3. Are the following statements true or false? Explain.
1) Depreciation can resolve the problem of payments deficit.
2) The supply curve of foreign currency is upward sloping.
3) Without government intervention, a balance of payments deficit will persist under a fixed exchange
rate system.

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