The global economy

50 marks: 12 multiple choice questions, a data response and an essay. Answers are at the end.

AQA: Questions 8, 9, 10, 11, 12 and 14 use the lesson "Exchange rates: appreciation and depreciation", which is not on your specification. You can still attempt them, and using the idea in an essay still earns credit. Question 14 would be a 25-mark question on your papers.

Edexcel: Questions 8, 9, 10, 11, 12 and 14 use the lesson "Exchange rates: appreciation and depreciation", which is not on your specification. You can still attempt them, and using the idea in an essay still earns credit. Question 14 would be a 25-mark question on your papers.

OCR: Questions 3, 4, 5, 6, 7, 13 (a), 13 (b) and 13 (c) use the lesson "Tariff diagram: free trade, protectionism and who gains", which is not on your specification. You can still attempt them, and using the idea in an essay still earns credit. Question 14 would be a 25-mark question on your papers.

Multiple choice online

The test

1A country has a comparative advantage in producing a good when it can produce it:

A in larger quantities than other countries
B at a lower opportunity cost than other countries
C at a lower money price than other countries
D using fewer workers and less capital than any other country

2Using all its resources, country A can produce 100 cars or 400 tonnes of wheat; country B can produce 50 cars or 300 tonnes of wheat. It follows that:

A A should specialise in cars and B in wheat
B A should specialise in wheat and B in cars
C there are no gains from trade, since A is better at both
D B has a comparative advantage in cars

3A tariff is:

A a ban on trade with a particular country
B a limit on the quantity of a good that may be imported
C a payment to domestic producers to help them compete with imports
D a tax on imported goods

4Other things being equal, the imposition of a tariff on imported steel will:

A reduce domestic output and government revenue
B raise the domestic price and increase imports as foreign firms cut their costs
C raise the domestic price, increase domestic output and reduce imports
D lower the domestic price and increase imports

5The world price of a good is £40 and a country imports 500,000 units. A tariff of £5 cuts imports to 300,000 units. The government's tariff revenue is:

A £2.5 million
B £1 million
C £4 million
D £1.5 million

6Which one of the following is the strongest economic argument for a temporary tariff?

A protecting a long-established industry from lower-cost foreign producers
B protecting an infant industry until it can compete at scale
C raising the price of imports so that consumers buy more domestic goods and jobs are saved
D retaliating against another country's tariffs

7A customs union differs from a free trade area in that its members:

A adopt a common external tariff on imports from non-members
B set their own tariffs on goods from outside the area
C allow the free movement of labour and capital
D share a single currency

8The pound falls from $1.30 to $1.20. A UK exporter sells a machine priced at £50,000. In dollars the machine now costs:

A $41,667 instead of $38,462
B $65,000 instead of $60,000
C $60,000 instead of $65,000
D $50,000 in both cases

9Which one of the following would be most likely to cause the pound to appreciate against the dollar in a floating system?

A speculators expecting the pound to fall
B a rise in UK interest rates relative to US rates
C a rise in UK inflation relative to US inflation
D an increase in UK demand for imports from the United States

10A depreciation of a country's currency is most likely to improve its current account balance when:

A its exports are priced in foreign currency and cannot change
B demand for its exports and imports is price inelastic
C demand for its exports and imports is price elastic
D the economy is at full employment

11The percentage change in the value of the pound when it moves from €1.25 to €1.15 is:

A −8.7%
B +8.7%
C −10.0%
D −8.0%

12To stop its currency falling under a managed exchange rate, a central bank could:

A sell foreign currency reserves and buy its own currency
B increase the money supply
C buy foreign currency with its own currency on the foreign exchange market
D cut interest rates

13In 2025 the United States raised tariffs on imports from almost every trading partner, with a baseline tariff of 10% and much higher rates on some countries and products, including 25% on cars and 50% on steel and aluminium. The UK agreed a deal that kept the 10% baseline but reduced the tariff on a quota of British cars to 10%. Economists estimated the average US tariff rate had risen to its highest level since the 1930s. Table 1 shows an illustrative market for a good imported into the United States.

Table 1: US market for an imported good (million units a year)
Price ($)	80	90	100	110	120
US demand	50	46	42	38	34
US supply	10	14	18	22	26

(a)The world price is $80. Using Table 1, calculate US imports before a tariff and the tariff revenue if a $20 tariff is imposed. [2]

(b)Using Table 1, calculate the change in US consumer spending on the good after the tariff and explain who gains and who loses from the tariff. [4]

(c)With the aid of a diagram, explain the welfare effects of a tariff on the importing country. [6]

(d)Explain two reasons why the US tariffs might fail to reduce the US trade deficit. [6]

14Evaluate the view that a fall in the value of the pound is good for the UK economy. [20]

Answers

Show the answers

AO1 knowledge, AO2 application, AO3 analysis, AO4 evaluation.

	Answer	Why
1	B	Comparative advantage is about what must be given up, not absolute efficiency; even a country that is worse at everything has a comparative advantage in something.
2	A	A's opportunity cost of a car is 4 tonnes of wheat; B's is 6 tonnes. A has the lower opportunity cost in cars, B in wheat (1/6 of a car against 1/4).
3	D	A tariff raises the domestic price of the import; a quota limits quantity, a subsidy supports producers and an embargo bans trade.
4	C	The higher price moves consumers down their demand curve and domestic producers up their supply curve; the gap, imports, shrinks.
5	D	Revenue = tariff per unit × units still imported = £5 × 300,000 = £1.5 million.
6	B	The infant industry case rests on dynamic economies of scale and is meant to be temporary; the others impose costs on consumers with no efficiency gain.
7	A	Free trade areas remove tariffs between members but each keeps its own external tariffs; a customs union adds a common one.
8	C	£50,000 × 1.20 = $60,000 against £50,000 × 1.30 = $65,000: a weaker pound makes UK exports cheaper abroad.
9	B	Higher relative returns attract hot money inflows, raising demand for sterling; the other three increase the supply of pounds or reduce demand for them.
10	C	The Marshall-Lerner condition: the sum of the elasticities must exceed one for a lower price to raise export revenue by more than import spending rises.
11	D	(1.15 − 1.25) ÷ 1.25 = −0.08, a depreciation of 8.0%.
12	A	Buying the domestic currency raises demand for it; cutting rates or printing money would push it lower.

13 (a) The world price is $80. Using Table 1, calculate US imports before a tariff and the tariff revenue if a $20 tariff is imposed. [2: AO2 2]

AO2 (1) At $80 imports = 50 − 10 = 40 million units
AO2 (1) At $100 imports = 42 − 18 = 24 million; revenue = $20 × 24 million = $480 million

13 (b) Using Table 1, calculate the change in US consumer spending on the good after the tariff and explain who gains and who loses from the tariff. [4: AO2 2, AO3 2]

AO2 (1) Before: 50 × $80 = $4,000 million; after: 42 × $100 = $4,200 million; spending rises by $200 million while 8 million fewer units are bought
AO3 (1) Consumers lose: they pay $20 more on each of the 42 million units and lose the surplus on the 8 million units no longer bought
AO3 (1) US producers gain: output rises from 10 to 18 million and they receive $100 rather than $80 on every unit, raising producer surplus; the government gains $480 million of revenue
AO2 (1) Foreign producers lose 16 million units of sales; part of the consumer loss is a transfer to producers and government, and part (the two triangles) is a deadweight loss to everyone

13 (c) With the aid of a diagram, explain the welfare effects of a tariff on the importing country. [6: AO1 2, AO2 1, AO3 3]

AO1 (2) Diagram: domestic demand and supply with a horizontal world supply at Pw and at Pw + t; imports shrink from Q1Q4 to Q2Q3; areas labelled: producer surplus gain (a), tariff revenue (c), deadweight losses (b and d)
AO3 (1) Consumers lose surplus equal to a + b + c + d because the price rises and quantity bought falls
AO3 (1) Area a is transferred to domestic producers and c to the government as revenue, so they are not lost to the country
AO3 (1) Area b is the production inefficiency (resources drawn into producing units at home that cost more than the world price) and d the consumption loss (units consumers valued above the world price but below the tariff price): a net welfare loss of b + d
AO2 (1) Application: in Table 1, b = ½ × 8 × $20 = $80 million and d = ½ × 8 × $20 = $80 million, a net loss of $160 million a year, before any retaliation or higher input costs for US firms using the good

Levels: 1 to 2 for a description with a partly correct diagram; 3 to 4 for a correct diagram with the transfers identified; 5 to 6 for the deadweight loss explained and applied.

13 (d) Explain two reasons why the US tariffs might fail to reduce the US trade deficit. [6: AO1 2, AO2 2, AO3 2]

AO1+AO2+AO3 (3) Retaliation and exchange rates: trading partners impose their own tariffs on US exports (China and the EU responded with counter-measures), cutting US export volumes; and if the tariffs reduce imports, the lower supply of dollars abroad tends to raise the dollar, making US exports dearer and imports cheaper, which offsets part of the effect
AO1+AO2+AO3 (3) The deficit reflects saving and investment, not tariffs: a trade deficit equals the gap between national investment and national saving; with large budget deficits and low household saving the US must import capital, so unless saving rises the deficit persists and tariffs mainly shift imports between countries (from China to Vietnam and Mexico) rather than cutting the total
AO1+AO2+AO3 (3) Or: many imports are inputs for US manufacturers (steel, components), so tariffs raise their costs and reduce their competitiveness abroad; demand for some imports is price inelastic in the short run, so spending on them falls little

Maximum 6: two reasons, each explained as a chain and applied.

14 Evaluate the view that a fall in the value of the pound is good for the UK economy. [20: AO1 6, AO3 6, AO4 8]

Knowledge and analysis (AO1 to AO3)

Define a depreciation (a fall in the pound's value against other currencies under a floating exchange rate) and its causes: lower relative interest rates, higher inflation, a current account deficit or a loss of confidence (the pound fell by about a tenth after the 2016 referendum and sharply in autumn 2022).
Benefits: exports become cheaper in foreign currency and imports dearer in pounds, so export volumes rise and import volumes fall; net exports rise and AD shifts right (diagram), raising output and employment with a multiplier effect; tourism and inward investment become more attractive; import-competing firms gain.
Current account: the Marshall-Lerner condition says the balance improves only if the sum of the price elasticities of demand for exports and imports exceeds one; in the short run contracts and habits make demand inelastic, so the balance may worsen first (the J-curve).
Costs: imported goods and raw materials cost more, raising the price level (cost-push inflation) and cutting real incomes; after 2016 inflation rose to 3% largely through import prices; firms that import components gain less than headline figures suggest, since much of UK manufacturing sits in global supply chains.
A weak pound can signal low confidence and raise the cost of borrowing; and if the economy is near full capacity the extra demand feeds prices rather than output.
Evidence: export volumes responded weakly to the post-2016 depreciation while prices rose; the 2022 fall came with rising inflation and higher interest rates; the 1992 and 2008 depreciations helped recovery when there was spare capacity.

Evaluation (AO4)

It depends on the cause: a depreciation driven by lower interest rates in a recession is helpful; one driven by a loss of confidence or higher inflation is a symptom of problems rather than a cure.
It depends on elasticities and the time horizon: short-run effects are often negative (J-curve) and the long-run gains depend on how elastic foreign demand for UK exports is, which for services and specialised manufactures may be low.
It depends on the state of the economy: with spare capacity the boost to AD raises output; near full employment it raises inflation, as in 2022.
It depends on the size and speed of the fall: a gradual, modest depreciation is easier to absorb than a sudden collapse that unsettles markets and raises borrowing costs.
'Good for the economy' hides winners and losers: it is good for exporters and bad for consumers, so the net judgement depends on which effect dominates and on whether the gain in output outweighs the loss of real income.

Judgement

A supported judgement might conclude that a depreciation can help the UK when it has spare capacity, when the fall is modest and when foreign demand for its exports is elastic, but that the UK's experience since 2016 shows the costs, higher import prices and weaker real incomes with little export response, can outweigh the benefits; a falling pound is a mixed blessing whose value depends on why it falls and on the economy's condition at the time.

Marking

Bands, out of 20 (AO1 knowledge 6, AO3 analysis 6, AO4 evaluation 8, as WJEC marks a 20-mark question). Top band (16 to 20): a range of points developed in full chains of reasoning, supported by an accurate diagram and real examples, with evaluation that weighs the arguments and reaches a judgement that depends on stated conditions. Middle band (9 to 15): some developed chains, a relevant diagram, evaluation present but one-sided or asserted. Bottom band (1 to 8): points listed or described, little use of theory or examples, judgement missing or unsupported.