IGCSE Economics Paper-2: Specimen Questions with Answers 93 - 94 of 100

Passage

“As budget deficits reached an estimated $ 1.6 trillion for 2009 and the government printed money to finance its financial rescue programs, other countries and investors started to get nervous. China, which holds the most dollar reserves, raised concerns about rising American debt, and some of its top officials floated proposals that would replace the dollar as the world՚s reserve currency.”

Question 93 (2 of 5 Based on Passage)

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What is the impact of depreciation in the value of currency?

Explanation

Depreciation in the value of currency means a fall in the rate of exchange. It is also known as devaluation in a fixed exchange rate system. Depreciation means that the value of currency is less as compared to other countries currency.

When There is a Depreciation, and the Exchange Rate Goes Down

  • Exports will become cheaper
  • Imports will be more costly
  • Depreciation in the value of currency will lead to the increase in domestic sales which will lead to creation of new jobs.
  • The increase in difference between exports and imports will increase the Aggregate Demand (AD) and will lead to acceleration in the economic growth.
  • It increases the rate of economic growth and reduces unemployment.

It tends to cause inflation because:

  • imports more expensive
  • higher domestic demand
  • Firms have less incentive to cut costs.

Improves the deficit in the current account.

Question 94 (3 of 5 Based on Passage)

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What do you understand by purchasing power parity?

Explanation

  • The way of determining the value of a product after adjustment of price differences and exchange rate is known as purchasing power parity. Concept of purchasing power parity helps in understanding the models of equilibrium rates. Two currencies are said to be in equilibrium or at par when basket of goods is priced at the same level in both the countries considering the exchange rate.
  • Example- It does not make sense to say that a book costs $ 30 in the US and £ 20 in UK. The comparison is not appropriate. If the exchange rate is £ 2/ $ , the book in UK is selling for $ 30, so the book is actually more expensive in UK.

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