S6 Economics Paper: International Trade, Exchange Rates And Growth (100 Marks)

S6 Economics Paper: International Trade, Exchange Rates and Growth (100 marks)

2026-11-11

S6 Economics paper on comparative advantage, tariffs and quotas, the balance of payments, exchange rates, growth and policy, with full answers and marking notes.

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Section A: Comparative advantage and gains from trade (12 marks)

The table shows the labour hours needed to produce one unit of cloth and one unit of wine in Countries A and B. Answer all parts and show your working.

#	Question	Answer and marking notes
1	(a) Calculate the opportunity cost of one unit of cloth and of one unit of wine in each country. (3 marks)	Answer: In Country A one cloth costs 2 / 4 = 0.5 wine and one wine costs 4 / 2 = 2 cloth. In Country B one cloth costs 6 / 3 = 2 wine and one wine costs 3 / 6 = 0.5 cloth. (Marking: 1.5 marks per country, all four values required.)
2	(b) State which good each country has a comparative advantage in, and explain. (3 marks)	Answer: Country A has a comparative advantage in cloth because its opportunity cost of cloth (0.5 wine) is lower than Country B 2 wine. Country B has a comparative advantage in wine because its opportunity cost of wine (0.5 cloth) is lower than Country A 2 cloth. (Marking: 1 mark conclusion, 1 mark per comparison.)
3	(c) If both countries specialise according to comparative advantage and trade one cloth for one wine, how much extra wine does Country A gain per unit of cloth exported? (2 marks)	Answer: Domestically one cloth is worth only 0.5 wine in Country A, but trade gives 1 wine for 1 cloth, so the gain is 1 – 0.5 = 0.5 wine per unit of cloth exported. (Marking: 1 mark working, 1 mark conclusion.)
4	(d) Distinguish between absolute advantage and comparative advantage, and explain why trade can still benefit both countries even when one country has an absolute advantage in both goods. (4 marks)	Answer: Absolute advantage compares input requirements for the same output; comparative advantage compares opportunity costs. Even if Country A needs fewer hours for both goods, the ratio of opportunity costs can still differ. Each country then specialises in the good where its opportunity cost is relatively lower and they exchange, so both obtain goods at a lower real cost. (Marking: 1 mark per concept, 2 marks for the specialisation and exchange reasoning.)

Section B: Tariffs, quotas and protectionism (12 marks)

A small open economy faces a world price of 50 dollars per unit. A 20 per cent ad valorem tariff raises the domestic price to 60 dollars and cuts imports from 400 to 250 units.

#	Question	Answer and marking notes
5	(a) Calculate the tariff per unit, the tariff revenue and the net welfare loss. (4 marks)	Answer: Tariff per unit is 50 x 20 per cent = 10 dollars, so the domestic price is 50 + 10 = 60 dollars, matching the data. Tariff revenue is 10 x 250 = 2,500 dollars. The net welfare loss is the two deadweight triangles, 0.5 x 10 x (400 – 250) = 750 dollars. (Marking: 1 mark each for the tariff, revenue, working and answer.)
6	(b) State two differences between a tariff and an import quota in their effects. (3 marks)	Answer: First, a tariff generates government revenue, whereas quota rents usually go to quota holders. Second, a tariff limits imports through price and quantity adjusts with supply and demand, while a quota fixes the quantity directly so the domestic price rise can be larger. (Marking: 1.5 marks per difference.)
7	(c) Explain three arguments for protectionism, giving one example of each. (3 marks)	Answer: First, infant industry protection, for example a tariff on local solar panel output until scale is reached. Second, national security, for example limiting dependence on imported food and energy. Third, protecting local jobs, for example a quota on textiles. Each argument needs its example. (Marking: 1 mark each.)
8	(d) State two benefits of free trade for consumers. (2 marks)	Answer: First, consumers pay lower prices because domestic prices move closer to world prices. Second, consumers enjoy a wider variety of goods as foreign products enter freely. (Marking: 1 mark each.)

Section C: The balance of payments (12 marks)

Balance of payments data for a year, in billions of dollars: goods exports 3,200, goods imports 3,600, services exports 900, services imports 500, income inflow 150, income outflow 250, net current transfers +50, net capital and financial account inflow 60.

#	Question	Answer and marking notes
9	(a) Calculate the goods trade balance and the services trade balance. (3 marks)	Answer: Goods balance is 3,200 – 3,600 = -400 billion (a deficit). Services balance is 900 – 500 = +400 billion (a surplus). (Marking: 1.5 marks each, correct sign required.)
10	(b) Calculate the current account balance and state whether it is in surplus or deficit. (3 marks)	Answer: Net income is 150 – 250 = -100 billion. The current account is -400 + 400 – 100 + 50 = -50 billion, a current account deficit of 50 billion. (Marking: 1 mark net income, 1 mark total, 1 mark conclusion.)
11	(c) Explain three possible causes of a current account deficit. (3 marks)	Answer: First, falling competitiveness, with slower export growth and rising imports. Second, rapid domestic income and consumption growth pulling in imports during a boom. Third, a strong currency or higher inflation than trading partners, which raises export prices and lowers relative import prices. (Marking: 1 mark each.)
12	(d) Given a net capital and financial account inflow of 60 billion, calculate the change in reserves and explain. (3 marks)	Answer: The current account plus the capital and financial account is -50 + 60 = +10 billion, so reserves rise by 10 billion. The balance of payments must balance overall, so the surplus inflow is added to official reserves. (Marking: 1 mark calculation, 1 mark reserve change, 1 mark explanation.)

Section D: Exchange rate changes and prices (16 marks)

An economy operates a linked exchange rate. The rate moves from 7.8 to 7.5 Hong Kong dollars per US dollar during the year. An export good is priced at 390 Hong Kong dollars locally and an import good at 20 US dollars abroad.

#	Question	Answer and marking notes
13	(a) Calculate the appreciation of the Hong Kong dollar against the US dollar, and the percentage changes in the export price in US dollars and the import price in Hong Kong dollars. (5 marks)	Answer: Appreciation is (7.8 – 7.5) / 7.8 x 100 = 3.85 per cent. The export price is 390 / 7.8 = 50.00 US dollars at first and 390 / 7.5 = 52.00 at year end, a change of +4.00 per cent. The import price is 20 x 7.8 = 156.00 Hong Kong dollars at first and 20 x 7.5 = 150.00 at year end, a change of -3.85 per cent. (Marking: 1 mark appreciation, 2 marks export, 2 marks import.)
14	(b) Explain how an appreciation of the Hong Kong dollar affects the local price level under a linked exchange rate. (3 marks)	Answer: An appreciation lowers the Hong Kong dollar price of imports, for example from 156.00 to 150.00, a fall of 3.85 per cent. Cheaper imported materials and consumer goods feed through costs and retail prices, easing local inflation and possibly causing imported deflation. (Marking: 1 mark price fall, 1 mark cost pass-through, 1 mark inflation effect.)
15	(c) Explain how an appreciation affects exporters and importers differently. (4 marks)	Answer: The exporter charges 390 Hong Kong dollars, which becomes 52.00 US dollars instead of 50.00, 4.00 per cent dearer, so foreign demand and margins may fall. The importer pays 20 US dollars, so cost drops from 156.00 to 150.00 Hong Kong dollars, saving 6.00 per unit and widening the margin. (Marking: 2 marks exporters, 2 marks importers.)
16	(d) Explain two conditions under which a depreciation improves the trade balance. (4 marks)	Answer: First, the sum of the price elasticities of export and import demand must exceed one, the Marshall-Lerner condition; otherwise the trade balance worsens. Second, elasticities are low in the short run, so the balance deteriorates first and improves later, the J-curve, and spare capacity is needed to meet the shifted demand. (Marking: 2 marks elasticity condition, 2 marks J-curve or capacity.)

Section E: Economic growth and living standards (20 marks)

Real GDP rises from 280 billion to 294 billion dollars while population rises from 7.00 million to 7.14 million.

#	Question	Answer and marking notes
17	(a) Calculate the growth rates of real GDP, population and real GDP per capita, and explain why they differ. (8 marks)	Answer: Real GDP grows by (294 – 280) / 280 x 100 = 5.00 per cent. Population grows by (7.14 – 7.00) / 7.00 x 100 = 2.00 per cent. Real GDP per capita is 280 / 7.00 = 400.00 at first and 294 / 7.14 = 411.76 at year end, a growth of 2.94 per cent. The gap arises because population also grows by 2.00 per cent, so per capita growth is well below total growth. (Marking: 2 marks per growth rate, 2 marks explanation.)
18	(b) Explain four sources of economic growth. (6 marks)	Answer: First, capital accumulation through machinery and infrastructure raising capital per worker. Second, human capital through education and training. Third, technological progress through research and new techniques raising total factor productivity. Fourth, better institutions and efficiency such as property rights, competition policy and openness improving allocation. (Marking: 1.5 marks each.)
19	(c) Explain why economic growth does not always raise living standards. (6 marks)	Answer: First, growth may bring pollution and environmental damage whose external costs offset higher income. Second, uneven distribution may concentrate gains, leaving most people little better off. Third, growth may come from longer hours and less leisure. Fourth, non-market activity and the shadow economy are excluded, so GDP misstates welfare. (Marking: 1.5 marks each.)

Section F: Macroeconomic policy and sustainable growth (28 marks)

An economy has a marginal propensity to consume of 0.8 and the government plans to raise spending by 4 billion dollars. In the same year the consumer price index rises from 105 to 110.

#	Question	Answer and marking notes
20	(a) Calculate the expenditure multiplier, the total effect of the spending increase on aggregate demand and the inflation rate, and explain the conditions for the multiplier to work fully. (10 marks)	Answer: The multiplier is 1 / (1 – 0.8) = 5.00, so aggregate demand rises by 40 x 5.00 = 200 billion dollars. Inflation is (110 – 105) / 105 x 100 = 4.76 per cent. Full multiplier effects require spare resources and unemployment, stable prices and interest rates, a stable marginal propensity to consume, sufficient domestic capacity and few leakages into imports or saving. (Marking: 2 marks multiplier, 2 marks total effect, 2 marks inflation, 4 marks conditions.)
21	(b) Discuss three limitations of expansionary fiscal policy in an open economy. (10 marks)	Answer: First, crowding out: government borrowing pushes up interest rates and reduces private investment and consumption. Second, import leakage: part of the extra income buys imports, so the multiplier spills abroad. Third, lags and political constraints: approval and construction take time, so the stimulus may arrive after the cycle turns, adding to inflation when the economy is near full employment. (Marking: 3 marks per limitation, 1 mark overall judgement.)
22	(c) Evaluate the relative effectiveness of supply-side policies and demand management in promoting long-term growth. (8 marks)	Answer: Demand management adjusts aggregate demand through spending and taxes and can stabilise output and jobs in the short run, but it does little for productive capacity and persistent expansion risks inflation, as the 4.76 per cent price rise shows. Supply-side policies act on capital, human capital, technology and institutions, shifting the production possibility curve and so are more effective for long-run growth though slower and less certain. The better approach combines both. (Marking: 3 marks demand side, 3 marks supply side, 2 marks conclusion.)

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