WJEC Eduqas Eduqas Component 2 2021-style practice: The exchange rate falls from 1 = \1.40to\pounds 1 = \1.26. Calculate the percentage depreciation of the pound and the new dollar price of a UK export priced at 200.

A short calculate question. The percentage change in the exchange rate, then the new export price. Depreciation: (1.26 - 1.40)/(1.40) × 100 = -10\%, so the pound has depreciated by 10 per cent. New dollar price of a 200 export: 200 × 1.26 = \252(down from200 \times 1.40 = \280). The export is now cheaper in dollars, so it is more competitive abroad. Markers reward the 10 per cent depreciation and the new dollar price (and ideally the point that exports become cheaper).

EnglandEconomicsSyllabus dot point

What determines exchange rates, and how do their movements affect the economy?

Exchange rates: floating and fixed (and managed) exchange rate systems, the determinants of a floating exchange rate, the effects of appreciation and depreciation, and the Marshall-Lerner condition and J-curve.

An Eduqas A520 answer to exchange rates, covering floating, fixed and managed systems, what determines a floating exchange rate, the effects of appreciation and depreciation on trade, inflation and growth, and the Marshall-Lerner condition and the J-curve effect.

Generated by Claude Opus 4.812 min answerUpdated 2026-06-02

Reviewed by: AI editorial process; not yet individually human-reviewed

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Quick answer

The exchange rate is the price of one currency in terms of another. Under a floating system it is set by supply and demand for the currency on the foreign-exchange market; under a fixed system the government pegs it and uses reserves and interest rates to defend the peg; a managed (dirty) float is mostly market-determined but with occasional intervention. A floating rate is determined by the demand for and supply of the currency, driven by trade flows, interest rates and hot money, investment (FDI), speculation and relative inflation. An appreciation (a rise in the currency) makes exports dearer and imports cheaper; a depreciation does the reverse. A depreciation tends to improve the current account and raise net exports, but raises import prices (cost-push inflation); the improvement depends on the Marshall-Lerner condition (the sum of the price elasticities of demand for exports and imports must exceed 1) and follows a J-curve (the balance worsens before it improves).

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What this dot point is asking
Exchange-rate systems
Determinants of a floating rate
Appreciation and depreciation
The Marshall-Lerner condition and the J-curve
Examples in context
Try this

What this dot point is asking

Eduqas wants you to distinguish floating, fixed and managed exchange-rate systems, explain what determines a floating rate, analyse the effects of appreciation and depreciation, and apply the Marshall-Lerner condition and the J-curve. Exchange rates link the domestic economy to international trade and the balance of payments.

Exchange-rate systems

Determinants of a floating rate

Appreciation and depreciation

A depreciation therefore tends to raise net exports and aggregate demand (boosting growth and employment) and to improve the current account, but it raises import prices, causing cost-push inflation and reducing the real purchasing power of consumers. An appreciation has the opposite effects: it helps control inflation (cheaper imports) but worsens competitiveness and the current account.

The Marshall-Lerner condition and the J-curve

Converting prices after a depreciation

Step 1: state the data

The exchange rate falls from $\pounds 1 = \$ 1.50 $to$ \pounds 1 = \ $1.20$ . A UK car is priced at $\pounds 20{,}000$ and a US machine is priced at $\$ 30{,}000$.

Step 2: find the new export price abroad

The UK car in dollars: before, $20{,}000 \times 1.50 = \$ 30{,}000 $; after,$ 20{,}000 \times 1.20 = \ $24{,}000$ . The export is now $\$ 6{,}000$ cheaper to American buyers, so it is more competitive.

Step 3: find the new import price at home

The US machine in pounds: before, $\frac{30{,}000}{1.50} = \pounds 20{,}000$ ; after, $\frac{30{,}000}{1.20} = \pounds 25{,}000$ . The import is now $\pounds 5{,}000$ dearer to UK buyers.

Step 4: interpret

The depreciation makes exports cheaper abroad and imports dearer at home (WIDEC). This should raise net exports and improve the current account if the Marshall-Lerner condition holds, but the dearer imports raise UK costs and prices (cost-push inflation), and the improvement may lag behind (the J-curve).

Examples in context

Sterling after 2016. The pound's sharp depreciation made UK exports more competitive but raised import prices and inflation, a textbook depreciation.
The eurozone. A monetary union fixes members' exchange rates against each other permanently, removing the depreciation tool for individual members.
Hot money flows. Interest-rate differences drive short-term capital between currencies, a major short-run influence on floating rates.

Try this

Q1. Explain two factors that could cause a floating currency to appreciate. [4 marks]

Cue. Any two of: higher relative interest rates (hot-money inflows), rising demand for exports, inward investment, or speculation expecting a rise.

Q2. Explain the J-curve effect following a depreciation. [4 marks]

Cue. In the short run the current account worsens (volumes adjust slowly, so dearer imports dominate); over time export and import volumes respond and the balance improves, tracing a J.

Exam-style practice questions

Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Eduqas Component 2 20214 marksThe exchange rate falls from

\pounds 1 = \

1.40

to

\pounds 1 = \

1.26

. Calculate the percentage depreciation of the pound and the new dollar price of a UK export priced at

\pounds 200

Show worked answer →

A short calculate question. The percentage change in the exchange rate, then the new export price.

Depreciation: $\frac{1.26 - 1.40}{1.40} \times 100 = -10\%$ , so the pound has depreciated by 10 per cent.

New dollar price of a $\pounds 200$ export: $200 \times 1.26 = \$ 252 $(down from$ 200 \times 1.40 = \ $280$ ). The export is now cheaper in dollars, so it is more competitive abroad. Markers reward the 10 per cent depreciation and the new dollar price (and ideally the point that exports become cheaper).

Eduqas Component 3 Section C 202012 marksEvaluate the likely effects of a depreciation of a country's exchange rate on its economy.

Show worked answer →

A levels-of-response essay. Knowledge and application: explain that a depreciation makes exports cheaper in foreign currency and imports dearer in domestic currency. Analyse the effects: net exports and AD tend to rise (raising growth and employment), but import prices rise (cost-push inflation), and the current account should improve over time.

Analysis: develop the effect on the current account, conditional on the Marshall-Lerner condition (the sum of the price elasticities of demand for exports and imports must exceed 1) and the J-curve (the balance worsens before it improves).

Evaluation: weigh the inflation cost, the dependence on elasticities and the J-curve lag, the effect on living standards (dearer imports), and the risk that trading partners retaliate or also devalue. Conclude with a supported judgement that a depreciation can boost competitiveness and the current account but at the cost of higher inflation and only if demand is sufficiently elastic.

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Sources & how we know this

Eduqas A Level Economics Specification (A520) — Eduqas (2015)